Key statement from the Federal Reserve: Raising interest rates is futile in the face of supply shocks.
2026-05-22 15:44:15
Today I'd like to share the views of Tom Barkin, president of the Richmond Federal Reserve, who is a moderately hawkish and conservative figure. These views align with yesterday's article, which discussed why strong employment and high inflation data do not necessarily support interest rate hikes, and the idea that hawks might not be ready to celebrate mid-rally.
He believes that in the past few years, the US economy has been hit by a series of supply shocks, from the global COVID-19 pandemic and the Russia-Ukraine conflict to the collapse of Silicon Valley Bank, the escalation of tariff disputes, and the recent escalation of conflicts in the Middle East.
At the same time, secondary fluctuations such as cargo ships blocking trade routes, outbreaks of avian influenza, and factory fires have frequently disrupted the market, directly impacting the effective supply of goods and services. Problems such as energy shortages, automotive chip supply disruptions, credit tightening, and wheat supply shortages have emerged one after another, and the market faces structural challenges in labor supply after the pandemic.
As the latest supply shock, the Middle East conflict has caused market volatility, but the impact has been less severe than initially expected.
The most direct manifestation is the phased rise in prices: gas station oil prices jumped, leading to a simultaneous increase in fuel surcharges, airfares, freight and packaging costs, and supply shortages of key production inputs such as fertilizers and aluminum.
This transmission effect is clearly reflected in inflation data. In March 2026, the year-on-year growth rate of core personal consumption expenditure (PCE) jumped to 3.5%, and the core inflation rate, excluding fluctuations in food and energy, also rose moderately to 3.2%, indicating some short-term inflationary pressure.
In stark contrast to the fluctuations in prices, the demand side of the US economy has demonstrated remarkable resilience in the face of risks.
Consumer spending did not contract due to rising costs; on the contrary, it continued to expand—this was not solely driven by high gasoline prices, but also by robust growth in non-gasoline consumption.
Corporate profits remain high, investment in artificial intelligence (AI) continues unabated, manufacturing sentiment data has bottomed out and rebounded, the S&P 500 index has repeatedly hit record highs, and non-farm payrolls have also shown signs of rebounding, indicating that overall economic activity has not been significantly suppressed.
The escalating conflict has not altered long-term consumption and investment decisions.
The “anchoring effect of long-term inflation expectations” is an important pillar of the Federal Reserve’s policy framework.
Traditional central bank theory holds that supply shocks typically only cause temporary price increases rather than sustained high inflation, and their impact on the economy is mostly short-term disturbances.
Thanks to what economists call the "anchoring effect of long-term inflation expectations," this strategy of "ignoring" supply shocks has been remarkably effective over the past generation. Businesses' and consumers' expectations of future inflation directly dominate actual inflation trends—determining the bargaining power of individuals in wage negotiations and the logic behind corporate pricing strategies.
When inflation expectations are "anchored," consumers clearly understand that inflation driven by factors such as short-term oil price increases is not equivalent to a long-term upward shift in the inflation center. They will not demand excessive pay raises due to short-term price fluctuations because they do not expect the increase in living expenses such as rent and groceries to be sustainable. Nor will they engage in forward-looking behaviors that exacerbate inflation, such as hoarding goods, out of concern for future inflation.
This stable long-term inflation expectation makes it difficult for short-term supply shocks to turn into spiral inflation, becoming the key to supporting economic resilience.
In other words, when the anchoring mechanism is strong enough, the waves cannot push the ship toward the reef, and the same is true for the anchoring effect of inflation expectations.
From a market perspective, although short-term inflation data has risen, there are currently no clear signs of a "retreat" in the consumer market or pressure on the labor market.
Although consumers are dissatisfied with rising prices (the University of Michigan Consumer Sentiment Index fell to a historic low in May), they are maintaining their spending resilience by turning to lower-priced products, making flexible choices among consumer categories, and utilizing diversified financing channels. There are no signs of a significant contraction in their willingness to spend.
In the labor market, companies have mainly improved efficiency in recent years by optimizing processes, increasing investment in technology and automation, and natural attrition, without taking large-scale proactive layoff measures. The current rebound in employment growth also indicates that companies remain cautiously optimistic about their long-term business prospects, and short-term supply shocks have not yet been transmitted to the labor demand side.
Based on the above judgment, the Federal Reserve's policy logic remains clear: it will not easily adjust interest rates due to short-term supply shocks causing fluctuations in inflation data.
The core reason is that raising interest rates to suppress aggregate demand cannot address the root cause of supply shocks—it cannot reopen blocked trade routes, restart shut-down factories, or alleviate energy shortages or chip supply disruptions. Instead, it may unnecessarily suppress normal economic activity.
Just as dealing with the egg shortage caused by avian flu cannot be solved by slowing down overall economic demand (i.e., raising interest rates), the Federal Reserve is more inclined to "set aside short-term disturbances" and focus on the stability of long-term inflation expectations in the face of current short-term inflation driven by the supply side.
Looking ahead, although geopolitical tensions, trade fragmentation, and extreme weather may lead to more frequent supply shocks, as long as the anchoring mechanism for long-term inflation expectations remains solid and the tolerance thresholds of businesses and consumers are not breached, the Federal Reserve will not need to raise interest rates hastily based on short-term inflation data.
At the last policy meeting, the Federal Reserve chose to keep interest rates unchanged. This decision was based on a prudent assessment of the duration and scope of the supply shock—allowing for a period of observation before the uncertainty is eliminated is a more prudent choice.
Going forward, the Federal Reserve will continue to monitor inflation trends, consumption, and labor market dynamics. It will only consider adjusting its policy when inflation shows a sustained upward risk and long-term inflation expectations begin to ease.
In the current environment, short-term inflation data is insufficient to justify raising interest rates. The Federal Reserve will adhere to its policy framework of "focusing on long-term inflation targets and ignoring short-term supply disturbances" to ensure that the economy remains stable amidst fluctuations.
The author believes that when the market narrative of interest rate hikes prevails, it may be worthwhile to refer to the ideas presented in this article, as this may coincide with a turning point in US Treasury yields and the US dollar, while also presenting good entry points for precious metals and equities.
He believes that in the past few years, the US economy has been hit by a series of supply shocks, from the global COVID-19 pandemic and the Russia-Ukraine conflict to the collapse of Silicon Valley Bank, the escalation of tariff disputes, and the recent escalation of conflicts in the Middle East.
At the same time, secondary fluctuations such as cargo ships blocking trade routes, outbreaks of avian influenza, and factory fires have frequently disrupted the market, directly impacting the effective supply of goods and services. Problems such as energy shortages, automotive chip supply disruptions, credit tightening, and wheat supply shortages have emerged one after another, and the market faces structural challenges in labor supply after the pandemic.
Recent shocks have translated into prices, and short-term inflationary pressures are emerging.
As the latest supply shock, the Middle East conflict has caused market volatility, but the impact has been less severe than initially expected.
The most direct manifestation is the phased rise in prices: gas station oil prices jumped, leading to a simultaneous increase in fuel surcharges, airfares, freight and packaging costs, and supply shortages of key production inputs such as fertilizers and aluminum.
This transmission effect is clearly reflected in inflation data. In March 2026, the year-on-year growth rate of core personal consumption expenditure (PCE) jumped to 3.5%, and the core inflation rate, excluding fluctuations in food and energy, also rose moderately to 3.2%, indicating some short-term inflationary pressure.
Demand resilience is evident, and economic activity has not been significantly suppressed.
In stark contrast to the fluctuations in prices, the demand side of the US economy has demonstrated remarkable resilience in the face of risks.
Consumer spending did not contract due to rising costs; on the contrary, it continued to expand—this was not solely driven by high gasoline prices, but also by robust growth in non-gasoline consumption.
Corporate profits remain high, investment in artificial intelligence (AI) continues unabated, manufacturing sentiment data has bottomed out and rebounded, the S&P 500 index has repeatedly hit record highs, and non-farm payrolls have also shown signs of rebounding, indicating that overall economic activity has not been significantly suppressed.
The escalating conflict has not altered long-term consumption and investment decisions.
The key role of the anchoring effect: short-term inflation is less likely to evolve into a long-term spiral.
The “anchoring effect of long-term inflation expectations” is an important pillar of the Federal Reserve’s policy framework.
Traditional central bank theory holds that supply shocks typically only cause temporary price increases rather than sustained high inflation, and their impact on the economy is mostly short-term disturbances.
Thanks to what economists call the "anchoring effect of long-term inflation expectations," this strategy of "ignoring" supply shocks has been remarkably effective over the past generation. Businesses' and consumers' expectations of future inflation directly dominate actual inflation trends—determining the bargaining power of individuals in wage negotiations and the logic behind corporate pricing strategies.
When inflation expectations are "anchored," consumers clearly understand that inflation driven by factors such as short-term oil price increases is not equivalent to a long-term upward shift in the inflation center. They will not demand excessive pay raises due to short-term price fluctuations because they do not expect the increase in living expenses such as rent and groceries to be sustainable. Nor will they engage in forward-looking behaviors that exacerbate inflation, such as hoarding goods, out of concern for future inflation.
This stable long-term inflation expectation makes it difficult for short-term supply shocks to turn into spiral inflation, becoming the key to supporting economic resilience.
In other words, when the anchoring mechanism is strong enough, the waves cannot push the ship toward the reef, and the same is true for the anchoring effect of inflation expectations.
Limited market impact: Consumer and labor markets not yet under pressure
From a market perspective, although short-term inflation data has risen, there are currently no clear signs of a "retreat" in the consumer market or pressure on the labor market.
Although consumers are dissatisfied with rising prices (the University of Michigan Consumer Sentiment Index fell to a historic low in May), they are maintaining their spending resilience by turning to lower-priced products, making flexible choices among consumer categories, and utilizing diversified financing channels. There are no signs of a significant contraction in their willingness to spend.
In the labor market, companies have mainly improved efficiency in recent years by optimizing processes, increasing investment in technology and automation, and natural attrition, without taking large-scale proactive layoff measures. The current rebound in employment growth also indicates that companies remain cautiously optimistic about their long-term business prospects, and short-term supply shocks have not yet been transmitted to the labor demand side.
The Fed's policy logic: Rejecting hasty interest rate hikes driven by short-term inflation.
Based on the above judgment, the Federal Reserve's policy logic remains clear: it will not easily adjust interest rates due to short-term supply shocks causing fluctuations in inflation data.
The core reason is that raising interest rates to suppress aggregate demand cannot address the root cause of supply shocks—it cannot reopen blocked trade routes, restart shut-down factories, or alleviate energy shortages or chip supply disruptions. Instead, it may unnecessarily suppress normal economic activity.
Just as dealing with the egg shortage caused by avian flu cannot be solved by slowing down overall economic demand (i.e., raising interest rates), the Federal Reserve is more inclined to "set aside short-term disturbances" and focus on the stability of long-term inflation expectations in the face of current short-term inflation driven by the supply side.
Looking ahead: Adhere to long-term goals and allow for a policy observation period.
Looking ahead, although geopolitical tensions, trade fragmentation, and extreme weather may lead to more frequent supply shocks, as long as the anchoring mechanism for long-term inflation expectations remains solid and the tolerance thresholds of businesses and consumers are not breached, the Federal Reserve will not need to raise interest rates hastily based on short-term inflation data.
At the last policy meeting, the Federal Reserve chose to keep interest rates unchanged. This decision was based on a prudent assessment of the duration and scope of the supply shock—allowing for a period of observation before the uncertainty is eliminated is a more prudent choice.
Going forward, the Federal Reserve will continue to monitor inflation trends, consumption, and labor market dynamics. It will only consider adjusting its policy when inflation shows a sustained upward risk and long-term inflation expectations begin to ease.
In the current environment, short-term inflation data is insufficient to justify raising interest rates. The Federal Reserve will adhere to its policy framework of "focusing on long-term inflation targets and ignoring short-term supply disturbances" to ensure that the economy remains stable amidst fluctuations.
The author believes that when the market narrative of interest rate hikes prevails, it may be worthwhile to refer to the ideas presented in this article, as this may coincide with a turning point in US Treasury yields and the US dollar, while also presenting good entry points for precious metals and equities.
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